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Chinese equities come back to life

byJohn Redwood

in Intermediaries

02.04.2019

The Chinese equity market has been strong this year. This has happened despite the continuing trade talks, the slowdown in Chinese activity, the fall in car and other industrial output, the restriction on exports and the tougher monetary climate enforced by the authorities. The figures in the second half of last year and in January and February showed a slowing economy. Car sales were hit by the credit squeeze and the 10% car tax. Manufacturing exports were hit by weaker sentiment reflecting the Trump tariffs and the tighter monetary policies being followed in the US, the Euro area and China itself.

The Chinese authorities are trying to carry out a difficult balancing act. They wanted to discipline a range of other financial institutions that were lending money outside the formal banking rules. They wanted to tidy up bank balance sheets where past loans had gone wrong. They felt overall debt levels were too high. They also though want to finance rapid transformation in the Chinese economy. They are trying to reduce industry based on an export model, where they have too much capacity for their own good. They want to boost domestic and service activity and consumption. They want to embrace the full digital revolution. They are out to promote a larger private sector of competing companies.

The last time the Chinese authorities tried to control the stock market too much they made mistakes – both ways. They allowed excessive credit and enthusiasm for shares in 2015 when they wanted to broaden the market and involve more people. They sent out signals to rein in the excess, only to see the market dive more than they wanted. It took time to get sufficient control to brake the fall. By the end of 2018 the equity market was half the level of the 2015 peak, with people still concerned about the slowdown, the trade war, the state of the car and investment goods markets and other global worries. Today the markets are being liberalised more.

Chinese shares are becoming a bigger proportion of the emerging market indices, and Chinese bonds are being added to the Bloomberg Barclays Global Aggregate Index. This is good news for values, as the first round effect will be inward flows as people increase their weightings in Chinese assets. With the indices buying them as a matter of course, more overseas investors will gain confidence in them and international liquidity in these instruments should grow. It will also create a pressure for better governance and transparency from Chinese companies and government which the Chinese authorities will not be able to block.

At the same time, President Xi is exerting more authority as he strengthens his position against rivals and dissenters. The trend to more centralised controls is not healthy for markets, and makes certain types of social media and digital development more difficult. He does however show a wish to get China to move closer to western institutional standards of behaviour in financial markets, and understands the more open systems of the West.

In the last few days the Chinese share market has come to life again, and is now showing excellent returns so far this year. The immediate news that helped was the publication of the PMI figures for March. These showed an improvement in manufacturing after pronounced weakness, with the figures suggesting increases in orders and output for the month after the slowdown. Whilst different dates for public holidays had some impact, it could also be at last a positive response to the reflationary action China is taking. More credit is being made available for working capital and investment. Banks have been freed to spend more money against their existing stock of capital.

We recommended China at the turn of the year. The market has now fulfilled our expectations on promises of reflation. There might be a bit more progress should there be a trade deal soon with the US, and should the Chinese authorities recognise they need to relax a bit more to be sure of powering their economic transformation at a decent pace.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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